Author: Satu Kauppinen
Publication date: 12.12.2023
In the world of finance and business, trust is the cornerstone of all transactions. However, trust can be fragile and sometimes, the temptation to engage in fraudulent activities becomes too great to resist. This is where forensic accounting, often described as the financial detective work of the modern age, comes into play.
What is forensic accounting?
Forensic accounting is a specialised field within accounting. It combines financial expertise with investigative skills. The goal is to uncover financial discrepancies, irregularities, and potential fraud. Actually, it’s a crucial tool in the fight against financial crimes, as it goes beyond traditional auditing or accounting practices.
Financial risk analysis
Forensic accountants go beyond the examination of financial statements, employing a holistic approach to investigations. They employ statistical analysis, market research, facility inspections, human source conversations, and psychological assessments. The goal is to reveal the truth. Let’s use scrutinising a company's income or expenses as an example. Forensic accountants request real-time data for the specific period in question to observe fluctuations more closely.
Risk management
Forensic accountants are not deployed on fishing expeditions but are a significant investment, requiring specific claims or concerns to investigate. A risk management framework helps companies identify, assess, and mitigate various risks. When financial irregularities, like unusually high repayment activity, are flagged, a forensic investigation may be triggered.
This is because increased repayment figures could indicate fraudulent activity. Investigative accounting techniques are crucial in three major risk areas: loans, investments, and M&A deals, audits, and the identification and investigation of financial irregularities.
Fraud risk
Investigative accountants adopt a physician's approach when probing for fraud, comparing reported data to expected norms. They scrutinise transactions for economic logic, especially when they deviate significantly from industry standards. Historical data is used to identify structural changes or breaks in correlations, indicating shifts in financial activity. What’s more, consistent deviations from analyst consensus expectations may suggest either legitimate financial management or manipulation.
Regulatory compliance risk
Companies operating across multiple states and countries face diverse regulatory compliance risks. These can include taxation, immigration, insurance, talent management, and data privacy. In fact, remote work is an increasingly popular trend as it compounds these complexities. For this reason, it is crucial for companies to assess financial risks associated with cross-border hiring and remote workers.
Forensic accountants are instrumental in identifying tax risks tied to remote work. In particular, they advise companies on when to consult tax experts for specific countries, ensuring compliance. For example, a remote work tax risk matrix helps risk professionals manage regulatory compliance.
Liquidity risk
Using investigative accountants to stress test a company's financial health is a proactive approach to mitigate liquidity risk. This approach is advocated by experts like Stettler. He has extensively analysed crises in financial markets. Investigative accountants play a crucial role in examining transaction portfolios. In particular, they assess counterparties' risk acceptance levels, and clarify the exposure of stakeholders to potential disasters.
Bank’s collapse
In one notable case, Stettler investigated a major US bank's collapse during the subprime mortgage crisis. He delved into the bank's risk frameworks, its complex hedging strategies, and managerial decisions. What’s more, he emphasises the need for external experts to assess risk using diverse models to prevent blind spots.
Principles-based accounting
As business environments evolve, principles-based accounting is expected to overshadow rules-based accounting. The shift towards principles-based accounting will likely increase the demand for investigative accounting services. They can offer a more sophisticated and adaptable approach to financial risk analysis. This trend can be expected to continue in the future as well.